Uber is the ultimate test of whether the last eight years of
venture investment in Silicon Valley was worthwhile.

Uber is valued at $60 billion. It's privately held. Nobody
outside its execs and a few investors really know what its books
look like.

If Uber someday turns into a highly successful company with a
massive market cap — say, equivalent to Facebook, which is now
worth over $300 billion — then this "unicorn" era of
billion-dollar startups will turn out to be, on balance, a win.

If Uber collapses under the weight of mounting losses, then the
last eight years of venture funding will have been revealed to be
a colossal waste and exercise in mass delusion.

Uber's importance became clear in the course of a remarkable pair
of essays from a couple of prominent venture capitalists this
week.

The argument centered on how much money a startup should take,
how much is too much, and what happens when the investment
climate turns sour before massively funded companies can get to
liquidity.

Uber as validation

He argues that Uber was smart to take advantage of a time of
extremely easy borrowing by borrowing a ton of money — it's taken
on equity investment of more than $9 billion and debt of $1.6
billion — and using that money to buy a whole bunch of things at
once.

It bought drivers by giving them hourly wage guarantees. Once it
had drivers on the road, it bought riders by offering heavy
discounts and using heavy marketing. This created a virtuous
cycle — more drivers meant faster pickups for riders, which meant
more riders would choose Uber, which meant more drivers would
sign up to drive, and so on.

Rothman argues this is how Uber came from behind — Lyft was
actually the first company to do this kind of ride-sharing — and
become dominant in the US.

Lyft CEO and cofounder
Logan Green, who came up with the ride-sharing business model
before Uber.David Paul
Morris/Bloomberg via Getty Images

Now, according to a recently leaked financial document that
Bloomberg reported, Uber makes an operating profit on each
ride in the US (as long as you don't count certain corporate-wide
expenses like taxes and equity compensation for employees), and
is now applying the same playbook overseas, where its losses are
still immense.

Rothman and his firm are not investors in Uber.

The dangerous unicorns

Then Benchmark's Bill Gurley wrote a long
but well-worth-the-read critique of the current funding
environment in Silicon Valley, which he called "dangerous for all
involved." The essay crystallizes what a lot of investors have
been saying for the last year or so as startup valuations
skyrocketed.

Gurley argues that a lot of startups are deluding
themselves by taking money at valuations they don't deserve and
know they cannot justify. These massive valuations are driven by
founder ego — running a billion-dollar company is a point of
pride! — and by early-in VCs who don't want to see the value of
their portfolio companies knocked down because that would make it
hard to raise new money for future venture funds.

This isn't just an academic argument to Gurley. He says it's
actually going to hurt everybody in the Silicon Valley food
chain.

Take a hypothetical unicorn that has been valued at over $1
billion but is nowhere close to covering its operating costs with
actual revenue from actual customers.

It can't go public because its books look too bad for retail
investors to take the risk. Earlier-round investors won't fund
later rounds at that valuation because they're already
overexposed, and if the company goes bankrupt they'll take that
VC's fund with them.

Benchmark's Bill Gurley.
His firm invested at Uber back when it was worth $60
million.Screenshot

So the only way this unicorn can raise money at its previous
valuation is by taking money from very savvy investors — Gurley
calls them "sharks" — who offer "dirty" term sheets that extract
all kinds of concessions.

Basically, these late investors only invest if they can be
guaranteed that they'll be paid first, and recoup the full value
of their investment, before any earlier investors get paid. If
this happens, everybody else who had a stake in the startup —
founders, employees with equity, early VC investors, and the
limited partners (LPs) who gave the money to the VCs to invest —
gets hosed. (There's a lot more to the essay than that; take 15
minutes and read
the whole thing.)

Gurley mentions a lot of troubled unicorn startups in his essay,
including
Theranos and
Zenefits. But he doesn't mention the biggest unicorn of all:
Uber.

Gurley's firm, Benchmark, led Uber's series A funding round in
2011. Uber had a valuation of $60 million at the time.

As
Sarah Lacy at Pando pointed out, one could read Gurley's
letter as expressing his extreme frustration that his early
investment is, on paper, worth 1,000 times what he paid for it.

But Uber keeps raising money and has no plans to go public any
time soon. That money is locked up. It's not a liquid investment.

Who's right?

Another VC (who asked not to be quoted by name) made an
interesting point to me last year. We were talking about the
dot-com bubble, and all the money that evaporated when companies
like Webvan and Pets.com went bust.

He argued that yes, a lot of money was wasted. But the money
taken in by all the startups who went bankrupt during that period
is dwarfed by the market cap of one single company created during
that period: Google (now Alphabet), which is now worth more than
$500 billion.

Google cofounders Larry
Page and Sergey Brin in the early days of the
company.AP

Add in Amazon, which started in the early dot-com era and is
worth almost $300 billion, and other companies on the edge of
that period like Salesforce (over $50 billion) and Yahoo (around
$30 billion, even if most of that value comes from a lucky or
prescient investment in Alibaba years after it started), and the
dot-com era looks like a huge win for investors on balance.

It just depends where you placed your bets, when you got in, and
when you got out.

In the next few years, a lot of overvalued unicorns and their
investors are going to run into exactly the squeeze that Gurley
laid out, and a lot of people are going to lose money.